Is Jiangxi Copper Company Limited (HKG:358) trading at a 42% discount?

In this article, we will estimate the intrinsic value of Jiangxi Copper Company Limited (HKG:358) by taking expected future cash flows and discounting them to their present value. We will use the Discounted Cash Flow (DCF) model for this purpose. Believe it or not, it’s not too hard to follow, as you’ll see in our example!

We generally believe that the value of a company is the present value of all the cash it will generate in the future. However, a DCF is just one of many evaluation metrics, and it is not without its flaws. If you still have burning questions about this type of assessment, take a look at Simply Wall St.’s analysis template.

Check out our latest analysis for Jiangxi Copper

The calculation

We use the 2-stage growth model, which simply means that we consider two stages of business growth. In the initial period, the company may have a higher growth rate, and the second stage is generally assumed to have a stable growth rate. To start, we need to estimate the cash flows for the next ten years. Wherever possible, we use analysts’ estimates, but where these are not available, we extrapolate the previous free cash flow (FCF) from the latest estimate or reported value. We assume that companies with decreasing free cash flow will slow their rate of contraction and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow more in early years than in later years.

Generally, we assume that a dollar today is worth more than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today’s dollars:

10-Year Free Cash Flow (FCF) Forecast

2023 2024 2025 2026 2027 2028 2029 2030 2031 2032
Leveraged FCF (CN¥, Million) CN¥6.37b CN¥6.80b CN¥6.61b CN¥6.52b CN¥6.48b CN¥6.49b CN¥6.53b CN¥6.59b CN¥6.66b CN¥6.74b
Growth rate estimate Source Analyst x1 Analyst x1 Is @ -2.74% Is @ -1.43% Is @ -0.51% Is at 0.13% Is at 0.57% Is at 0.89% Is at 1.11% Is at 1.26%
Present value (CN¥, million) discounted at 12% CN¥5.7k CN¥5.4k CN¥4.7k CN¥4.1k CN¥3.7k CN¥3.3k CN¥2.9k CN¥2.6k CN¥2.4k CN¥2.1k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year discounted cash flow (PVCF) = CN¥37b

We now need to calculate the terminal value, which represents all future cash flows after this ten-year period. The Gordon Growth formula is used to calculate the terminal value at a future annual growth rate equal to the 5-year average 10-year government bond yield of 1.6%. We discount terminal cash flows to present value at a cost of equity of 12%.

Terminal value (TV)= FCF2032 × (1 + g) ÷ (r – g) = CN¥6.7b × (1 + 1.6%) ÷ (12%– 1.6%) = CN¥65b

Present value of terminal value (PVTV)= TV / (1 + r)ten= CN¥65b÷ ( 1 + 12%)ten= CN¥21b

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total equity value, which in this case is 58 billion Canadian yen. To get the intrinsic value per share, we divide it by the total number of shares outstanding. Compared to the current share price of HK$10.6, the company appears to be pretty good value at a 42% discount to the current share price. Remember though that this is only a rough estimate, and like any complex formula – trash in, trash out.

SEHK: 358 Discounted Cash Flow November 13, 2022

Important assumptions

We emphasize that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you disagree with these results, try the math yourself and play around with the assumptions. The DCF also does not take into account the possible cyclicality of an industry, nor the future capital needs of a company, so it does not give a complete picture of a company’s potential performance. Since we consider Jiangxi Copper as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which takes debt into account. In this calculation, we used 12%, which is based on a leveraged beta of 1.758. Beta is a measure of a stock’s volatility relative to the market as a whole. We derive our beta from the average industry beta of broadly comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable company.

SWOT Analysis for Jiangxi Copper

Strength
  • Earnings growth over the past year has exceeded that of the industry.
  • Debt is well covered by income.
  • Dividends are covered by earnings and cash flow.
Weakness
  • Earnings growth over the past year is below its 5-year average.
  • The dividend is low compared to the top 25% dividend payers in the metals and mining market.
Opportunity
  • Annual revenues are expected to increase over the next 3 years.
  • Trading below our estimate of fair value by more than 20%.
Threatens
  • Debt is not well covered by operating cash flow.
  • Annual earnings are expected to grow slower than the Hong Kong market.

Let’s move on :

Valuation is only one side of the coin in terms of crafting your investment thesis, and ideally it won’t be the only piece of analysis you look at for a company. DCF models are not the be-all and end-all of investment valuation. Preferably, you would apply different cases and assumptions and see their impact on the valuation of the business. For example, changes in the company’s cost of equity or the risk-free rate can have a significant impact on the valuation. Can we understand why the company is trading at a discount to its intrinsic value? For Jiangxi Copper, we’ve put together three more factors for you to evaluate:

  1. Risks: We believe that you should evaluate the 1 warning sign for Jiangxi Copper we reported before investing in the company.
  2. Future earnings: How does 358’s growth rate compare to its peers and the market in general? Dive deeper into the analyst consensus figure for the coming years by interacting with our free analyst growth forecast chart.
  3. Other strong companies: Low debt, high returns on equity and good past performance are essential to a strong business. Why not explore our interactive list of stocks with strong trading fundamentals to see if there are any other companies you may not have considered!

PS. The Simply Wall St app performs an updated cash flow assessment for each SEHK stock every day. If you want to find the calculation for other stocks, search here.

Valuation is complex, but we help make it simple.

Find out if Jiangxi copper is potentially overvalued or undervalued by viewing our full analysis, which includes fair value estimates, risks and warnings, dividends, insider trading and financial health.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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